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Purchase order financing – how it works

The assets of a company or business are linked to its equipment & machinery, inventory, current client orders, open invoices and even real estate holdings, based on what Doug Foshee teaches in his business classes.

But when it comes to securing working capital in terms of loans and financing the commonly used assets are mostly equipment & machinery. This is however increasingly changing, with customer orders becoming a popular source of quick capital for businesses that urgently need funding. Purchase order financing is the short term commercial financing a business seeks which offers financing for the upfront payment of suppliers for existing and verified purchase orders.

Purchase order financing is increasingly opening up opportunities for businesses to raise capital and secure finances for business growth. The open orders, long-term agreements and customer contracts are now being used as collateral by businesses to secure finances. Understanding how purchase order financing works is simple since it depends on very basic steps. The business simply presents written purchase orders, for goods or products from customers, to a financing company and then the financer or lender provides funding for even up to 100% of the order values. In other words, the lender transforms the purchase orders to cash receivables and offers an advance on the receivable cash. Here are a few tips on how it works.

Advance on customer’s order’s value

Purchase order financing for small and medium sized businesses works by lenders offering cash advance of a percentage of the customer’s order’s value.

This means that a company is funded by either bank or non-bank lenders based on orders and contracts from customers that are already in existence. The cash advance allows a business to make purchases of raw materials needed to process the customer’s order.

Lender Collects payment from customer

Upon processing of the raw materials into finished goods, i.e. the final order, the lender collects from the customer based on the invoice and once the customer pays the invoice in full, the lender proceeds to pay the business the difference between the given advance and the client’s payment, which is considered the company’s profit.